Download Rising Interest Rates and Your Portfolio

Rising Interest Rates
and Your Portfolio
With long-term interest rates having finally begun to move, bond investors are right
to wonder what to do. Here, a thoughtful strategy for navigating the new environment.
When U.S. Federal Reserve Chairman Ben S. Bernanke
testified before Congress in mid-May and addressed the
Fed’s plans for tapering off its monetary stimulus programs,
it touched off a two-week sell-off in U.S. Treasury notes that
propelled the yield on the 10-year Treasury note up by 40
basis points—the sharpest one-month rise since December
2010. Bond prices fell nearly across the board.
The sudden market move in response to what has become
known as the “Taper Talk” was a microcosm of the more
pervasive unease surrounding the Fed’s eventual exit
strategy. Some fear that those plans could eventually induce
a much sharper rise in interest rates and a much steeper
drop in the value of bond holdings. “Clearly, the bond markets
are a little jumpy,” says Christopher J. Wolfe, chief investment
officer of the Private Banking and Investment Group at
Merrill Lynch. “There’s this concern out there that once the
Fed removes its foot from the brakes that have kept interest
rates low, they’re going to take off and it’s going to be the
early 1980s all over again, with rates of 10%, 12%, 15%, and
anyone sitting in long-dated bonds with fixed yields at 2%,
3% is going to get hammered. But there are a lot of other
forces at work still pushing down on interest rates.”
Interest rates, after all, aren’t just a function of Federal
Reserve policy, Wolfe notes. They’re also driven by the
demand for capital (and, hence, the cost of capital), and for a
variety of reasons that demand looks to remain weak: a U.S.
economy puttering along with an annual growth rate of just
2.5%, stubbornly high unemployment, recession in Europe,
corporations that are still reluctant to reinvest, and aging
populations in the U.S. and other developed countries that
are spending less as they grow older.1
The Fed itself is acutely aware of the headwinds facing the
economy. From the time it embarked on its quantitative
easing (QE) program five years ago to stimulate economic
activity by forcing down long-term interest rates through
the purchase of long-dated government securities, its stated
goal has been to reduce unemployment levels to around 7%
and to boost inflation to a level it felt was more consistent
with a healthy, growing economy. Even during his Taper
Aging baby boomers aren’t just downsizing their personal expenditures, they’re also buying more bonds as they turn more conservative in their investments as they near retirement. It’s one
reason that even as equities have outperformed bonds in recent quarters, bond flows continue to outpace equity flows—and another factor that could support bond prices going forward.
1
Merrill Lynch Wealth Management makes available products and services offered by Merrill Lynch, Pierce, Fenner & Smith Incorporated
(MLPF&S) and other subsidiaries of Bank of America Corporation.
Investment products:
Are Not FDIC Insured
Are Not Bank Guaranteed
May Lose Value
MLPF&S is a registered broker-dealer, a registered investment advisor, member SIPC and a wholly owned subsidiary of BAC.
Talk in May and subsequent clarification in June, Bernanke
emphasized that the soonest he could foresee meeting those
employment and inflation targets would be sometime in 2014.
He also stated that once the targets were within sight and the
Fed began winding down its long-term policies, it would keep up
its actions to suppress short-term rates for another year. “As long
as the Fed is injecting funds into the bond market,” says Martin
Mauro, fixed-income strategist for BofA Merrill Lynch Global
Research, “it will be hard for interest rates to rise substantially.”
Treasury note, which stood at 2.12% on June 1 of this year,
settling at about 2.4% by the end of 2013, according to the
rates team. By the end of 2014, they project it reaching
about 3%.2
Of course, even rate increases of that size can have a
negative impact on investors’ bond portfolios. The table on
this page illustrates the effect that as much as a 100 basis
point rise in prevailing interest rates would have on a sample
moderate investor’s fixed-income portfolio.
That’s why the firm’s rates strategists have forecast a mild
(if occasionally volatile) rise in interest rates over the next
six to 18 months, as market prices lower the demand created by
bond managers as they sell off longer-dated bonds in anticipation
of the Fed’s moves. This should see the yield on the 10-year U.S.
As shown, while some portions of the portfolio would be
more negatively impacted than others, the overall effect
would likely cause a total return (yield net the change in the
securities’ market value) of –2%.
The Real Impact on the Portfolio
The following analysis shows the effect of interest rate hikes of up to 1% on a sample moderate investor’s bond portfolio.
Longer-dated bonds saw the biggest price drops, while overall total return (net the yield from the bonds) was –2%.
Moderate Recommended Par-Weighted
Allocation
Coupon*
Price Return from Increase in Interest Rates
Effective
Duration*
25 BPS
50 BPS
75 BPS
100 BPS
U.S. Treasuries
Treasuries
11%
2.4%
5.9
–1.5%
–2.9%
–4.4%
–5.9%
TIPS
2%
1.4%
5.7
–1.4%
–2.8%
–4.2%
–5.7%
U.S. Municipals
58%
4.7%
7.5
–1.9%
–3.8%
–5.6%
–7.5%
U.S. Investment Grade
11%
4.8%
6.8
–1.7%
–3.4%
–5.1%
–6.8%
High Yield
3%
7.6%
4.3
–1.1%
–2.2%
–3.3%
–4.3%
Mortgage-Backed Sec's
10%
4.1%
4.0
–1.0%
–2.0%
–3.0%
–4.0%
Preferreds
1%
6.6%
7.3
–1.8%
–3.7%
–5.5%
–7.3%
Non-U.S. Sovereigns
1%
2.8%
7.4
–1.9%
–3.7%
–5.6%
–7.4%
Emerging Markets: USD
1%
6.8%
7.2
–1.8%
–3.6%
–5.4%
–7.2%
Emerging Markets: Local
2%
6.3%
5.2
–1.3%
–2.6%
–3.9%
–5.2%
–1.7%
–3.4%
–5.0%
–6.7%
2.8%
1.1%
–0.5%
–2.2%
U.S. High Yield & Collateralized
Emerging-Market Debt
Price Return
Total Return (yield net change in securities’ market value)
4.5%
*BofA Merrill Lynch Bond Indexes used to represent the various sectors of the bond market; As of May 31, 2013.
This table is a hypothetical example meant for illustrative purposes only. Strategic allocations are hypothetical and are not intended to indicate specific investment recommendations
or advice.
2
“Interest Rate Forecasts: Modest Upward Revisions,” BofA Merrill Lynch Global Research, June 11, 2013.
Rising Interest Rates and Your Portfolio2
What the Fed is Watching
While all eyes are on the U.S. Federal Reserve, investors can look at the data the Fed will use to help determine
when to begin tapering its easy monetary policy. And that data is improving—slowly.
BofA Merrill
Lynch Research
Forecast
7.0%
12.0%
5.0%
10.5%
3.0%
9.0%
1.0%
7.5%
-1.0%
6.0%
-3.0%
4.5%
-5.0%
3.0%
-7.0%
1.5%
-9.0%
DEC 03
0.0%
DEC 04
DEC 05
DEC 06
DEC 07
DEC 08
DEC 09
Source: Factset, BofA Merrill Lynch Research, and Merrill Lynch Investment Management & Guidance. As of June 5, 2013.
All of this suggests, Wolfe argues, that investors consider
taking steps to preserve their portfolios. What it doesn’t
support are sudden, wholesale changes that could be
detrimental to an investor’s overall allocation strategy or
inconsistent with other goals. “Clients should think about
this as a risk that could develop over time,” he says. “It is
more likely to be a process rather than an event. The good
news is that it also means clients have time to really work
with their advisors to design a well-thought-out strategy for
how to prepare.”
A GOALS-BASED APPROACH TO INTEREST
RATE MANAGEMENT
The prospect of rising interest rates has caused some
investors to question the wisdom of holding bonds in
their portfolios at all. In many cases, that could be an
overreaction, says Wolfe. “Clients need to think about the
reasons they invested in bonds in the first place. What were
the goals they were trying to achieve?” Take for example, a
tranche of five-year bonds paying 2.5% due to mature next
year that have been set aside to fund the purchase of a new
vacation home. Whether interest rates rise between now
and then is almost beside the point, says Wolfe, because
DEC 10
DEC 11
DEC 12
DEC. 13
U.S. GDP (% chg QoQ)
U.S. Unemployment (SA, Right)
The prospect of rising interest
rates has caused some
investors to question the
wisdom of holding bonds in
their portfolios at all.
either way you are likely to hold the bonds to maturity and
stick to the original strategy. The same goes for a small
bond portfolio with bonds due to mature in successive years
to fund a grandchild’s education, or longer-dated bonds
being counted on to supplement an elderly relative’s nursing
care. “Could you tweak the holdings to better position them
in this environment? Sure,” says Wolfe. “But you need to
balance that against the downside of disrupting a strategy
that’s working for you now.”
Of course, among the goals investors hope to achieve with
fixed-income investments are wealth accumulation and risk
management. After a historic 30-year bull market in bonds
that has left many investors with sizable rewards for their
Rising Interest Rates and Your Portfolio3
Why the Worst-Case Scenario
Doesn’t Quite Add Up
Curves Ahead
The “yield curve” is the standard snapshot of what bonds
across a range of maturities are paying at any given time.
As shown here, it has started to steepen.
Yield Curve (U.S.)
Some of the fears surrounding the Fed’s exit strategy
for its current policies are based on a misunderstanding
of the way the money system really works.
3.5
3.0
2.5
1.5
Yield (%)
2.0
1.0
Source: Factset and Merrill Lynch Global Wealth Management
Investment Management & Guidance. As of May 21, 2013.
30Y
20Y
15Y
10Y
5Y
6M
1Y
2Y
3Y
0.5
0.0
As of May 21, 2013
One week earlier
One month earlier
One year earlier
commitment to the asset class, there is a growing sense
that the run could be over and that it’s time to beat an exit
to the equity markets. But here again, Wolfe says, investors
need to proceed with the bigger picture in mind.
In the kind of environment forecast by BofA Merrill Lynch
Global Research over the next 18 months—with a gradually
improving economy pushing interest rates up, and the
Fed managing a reasonably smooth transition out of its
accommodative policies—equities would be in position to
perform well. However, Wolfe notes that tail risks exist both
in Washington and elsewhere, and rates and inflation could
potentially rise more than expected. In that case, the right mix
of fixed income could play a key diversification and wealthpreservation role that helps keep overall portfolio volatility
down. “It’s not a simple, binary, in-bonds/out-of-bonds
decision,” he says. “If designed correctly, these allocation
decisions all should be working for you at multiple levels.”
As a start, Wolfe says that investors should talk with their
advisors about potentially breaking from their standard
long-term allocation in favor of a short-term (12- to
18-month) tactical allocation somewhat more heavily tilted
toward equities. If the long-term ratio was 60% stocks, 40%
Few topics in finance these days stir as much emotion as interest
rates and inflation. While BofA Merrill Lynch Global Research
forecasts a relatively moderate trajectory for interest rates over
the next 18 months, some fear a far less benign outcome. At the
heart of their argument is a general worry about Federal Reserve
policy and lack of confidence in its ability to exit its quantitative
easing (QE) program in an orderly fashion. In essence, such critics
worry that the Fed’s historic bond-buying program amounts to
printing money that will eventually spark an inflationary spiral
that leads to a return of the soaring rates and “stagflation” of the
1970s and early ’80s.
There are elements of truth to these assertions, but they also
represent an oversimplification of the way the modern banking
system works. In effect, there are two forms of money: the kind
we use on a day-to-day basis, and the kind of accounting entries
that the Fed uses to conduct its business. When the Fed buys
bonds from private financial institutions, as it has since 2010 in its
efforts to stimulate private lending, it credits the excess reserves
those institutions have on deposit at the Fed. It’s true that this
has effectively brought trillions of dollars into existence that
didn’t exist before, and that as banks lend some of that money
out it does get into the day-to-day economy (which was the Fed’s
intention). But the Fed also has the ability to stop the flow of
those dollars into the economy, and to reduce the money supply
with the same strokes of the keyboard it used to increase it.
When people talk about the Fed’s “unwinding” of its QE bond
portfolio, this is what they are referring to. The unwinding will
likely take place in a few different ways. The Fed can hold the U.S.
Treasury bonds it purchased all the way to maturity, receiving a
credit from the Treasury Department that they can then simply
delete from its balance sheet. (The Fed has already let many of its
bonds mature, but so far has used those credits to purchase still
more Treasuries.) Similarly, the Fed may eventually choose to sell
some of its bonds on the open market, taking the cash it receives
and digitally erasing it as well.
Furthermore, if the Fed still felt the economy was heating too
quickly, it could raise the rates on bank reserves, encouraging
private financial institutions in the U.S. to keep more cash on
their own balance sheets, turning back down the throttle on
private lending. The tricky part will come in striking the right
balance as the money supply is re-tightened, but not so sharply
as to hamper the economic recovery. “The Fed has many things
to consider simultaneously. But there is one thing that makes
it less dangerous and that’s time,” says Ethan Harris, chief U.S.
economist for BofA Merrill Lynch Global Research. Given that
inflation has thus far remained well in check, he adds: “At this
stage, it looks like they’ll have time to figure it out.”
Rising Interest Rates and Your Portfolio4
The longer a bond’s duration,
the less attractive it will be
when interest rates rise, since
it will pay less income than
newer bonds.
bonds, for example, the tactical recommendation might now
be about 65% equities, 33% bonds and 2% cash. Aggressive
investors might go as high as 85% stocks and 13% bonds.
SHORTER DURATIONS AND HIGHER YIELDS
Another step would be to trim the durations of the bonds
held in a portfolio—buying those with shorter-term
maturities and selectively selling those with terms longer
than 10 years. The longer a bond’s duration, after all, the less
attractive it will be when interest rates rise, since it will pay
less income than newer bonds pegged to the higher rates,
and do so over a longer period of time than shorter-duration
bonds. For this reason, the prices of shorter-dated bonds are
generally less sensitive to rising interest rates.
But shorter-duration bonds also pay less income over time.
To make up for that loss, investors with the appropriate
risk profile can seek to exchange some of their interest
rate risk for credit risk by selectively acquiring fixed-income
assets that deliver bigger coupons—for example, high-yield
corporate bonds. An important argument for taking on more
credit risk is that if the economy is on a sustainable growth
track, a broader swath of companies should potentially be
in a stronger position to pay their debts, lowering the real
risk of holding their paper. (Though, as always, in-depth
research by experienced analysts is needed to find those
least susceptible to downgrades.) A similar approach can be
applied to the tax-exempt part of the fixed-income portfolio
via the consideration of high-yield municipal bonds for a
small portion of one’s muni holdings.3
If investors are going to own fewer bonds and thus have
fewer income streams, they may also consider gaining more
exposure to dividend-paying stocks. Wolfe advises focusing
3
Hedging Your Interest Rate Risk
Or, how “TIPS” and “swaptions” may be part
of the strategy.
Investors who have considerable interest rate risk—those with
approximately $5 million in fixed-income holdings or more—may
want to consider some more direct steps to hedge that risk.
One simple strategy involves the popular instruments known as
TIPS, or Treasury Inflation-Protected Securities. A type of bond
issued by the U.S. government, they’re designed to track the
consumer price index, therefore gaining value alongside inflation.
So, to the degree that interest rates eventually move up in tandem
with inflation (as BofA Merrill Lynch Global Research expect they
will at some point), TIPS would provide some protection.
An even more direct approach is to use what’s known as an interest
rate “swaption.” As the name implies, a swaption is a combination
of a swap and an option. Interest rate swaps are most frequently
used by private investors who have a floating-rate-based loan and
want to protect themselves against the possibility of rates going
up. Via the swap, the private investor holding the loan “swaps”
floating-interest-rate payments in exchange for fixed-interest-rate
payments. The investor pays a counterparty (like Bank of America
Merrill Lynch) a fixed-rate payment each month in exchange for
a floating-rate-payment based on the prevailing floating-interest
rate as determined by a measure like LIBOR (the London Interbank
Offered Rate). Receiving a floating rate on a swap offsets the
floating rate owed on the loan, effectively making the investor
indifferent to any rise in rates.
In theory, swaps, which are tradeable, can also be used to protect
against the declining value of a bond portfolio due to interest rate
risk. In such cases the parties would simply agree on a principal
amount, called the “notional,” and exchange their interest rate
payments based on that. For example, if the notional is $10 million
for a 10-year swap, the client might agree to pay a fixed rate of 3%
per year in exchange for receiving a floating rate, such as threemonth LIBOR. As rates go up, the floating side would as well.
The problem with this approach, says Christopher J. Wolfe, chief
investment officer of the Private Banking and Investment Group
at Merrill Lynch is that “it’s an awfully cash-intensive way to buy
yourself bond protection. Plus, now you’ve got this new risk you’re
exposed to each month if interest rates don’t end up moving in the
direction you thought.”
In a swaption, on the other hand, investors agree to the option,
not the obligation, to enter into a swap. To purchase an option on
the same $10 million notional, they will pay a onetime up-front
premium, typically several hundred thousand dollars. The swaption is
also a tradeable instrument and the market is relatively liquid, so if
rates go up investors can take their gains and get out at any time.*
And if they’re wrong about interest rates, the most they can lose is
the original premium.
*If a customer decides to terminate his/her contract before the exercise date there is
the risk that the Swaption could be worth less than the premium the customer paid.
B
ecause many municipalities around the country face pension obligations and other fiscal challenges, investing in municipal bonds can be tricky. Investors should try to diversify their
holdings and may want to consider actively managed funds specializing in this area.
Rising Interest Rates and Your Portfolio5
the search on companies with favorable prospects and a
solid track record of regularly hiking their dividends, which
could have the related benefit of bolstering a portfolio’s
defenses against inflation. Real estate investment trusts
(REITs), securitized pools of commercial and residential
holdings in the improving commercial and residential real
estate markets, and master limited partnerships (MLPs),
which sell shares in pipelines, drilling rigs and other
infrastructure in the booming U.S. energy sector, may
figure into the discussion as well.4
As with any form of risk management in investing,
diversification is key. Portfolios should contain an array of fixedincome assets of differing types as well as maturities. Often in
an environment such as this one, investors will set up what are
known as very short-term “ladders.” A typical example might
feature “rungs” of one-, two- and three-year bonds. The idea
is that when the one-year notes come due, the proceeds can
be used to purchase new three-year bonds offering what by
then are presumably higher yields. Within types of bonds, Wolfe
recommends thinking in terms of a “core and satellite,” with the
satellite composed of higher-yielding securities representing
perhaps 20% to 40% of the fixed-income total, and a core of
Treasuries, investment-grade corporates and federally backed
mortgage securities accounting for the rest.
GOING GLOBAL
ln essence, diversification in fixed income means spreading
interest rate risk around, and using the discrepancies
between the kinds of risks being priced into the market
to your advantage. Another way to do that is to search for
some of your yield from countries and companies overseas.
It’s the same idea as investing in BBB-rated U.S. corporate
bonds: If five-year Indonesian sovereign bonds are currently
yielding 5% at a time when five-year Treasuries are yielding
1%, the “par,” or market value, of those bonds should be less
affected as rates start to rise.5 Further, while the debt of
emerging-market economies is generally deemed riskier than
the debt of the developed world (hence the higher yields),
4
5
6
Low and Lower
Even as 10-year Treasury yields have begun to inch up,
short-term London Interbank Offered Rates (LIBOR)
remain pinned to the floor.
21
18
15
12
Quantitative
Easing begins
9
6
3
0
‘80 ‘82 ‘84 ‘86 ‘88 ‘90 ‘92 ‘94 ‘96 ‘98 ‘00 ‘02 ‘04 ‘06 ‘08 ‘10 ‘12
Source: Federal Reserve Board, BofA Merrill Lynch Global Research.
As of June 3, 2013.
3-mo LIBOR
10-year TSy (%)
As with any form of risk
management in investing,
diversification is key.
many such nations actually have better balance sheets at
this point than their peers in Europe and North America.
The common thread here is that you are striving to locate
inefficiencies: finding those areas of the bond market
where the market is wrong. But attempting to outsmart
the bond markets isn’t easy. In addition to the vagaries of
geopolitics and local economic conditions, there are currency
fluctuations to consider that can wipe out (or, conversely,
multiply) returns from foreign-currency-denominated bonds
when the proceeds are repatriated back into U.S. dollars.6
This is where fixed-income managers can help. Dedicating
a portion of a portfolio to stakes in actively managed
A
fter a surge that saw the Dow Jones Equity All-REIT Index gain 20% in 2012, residential mortgage REITs (the kind most vulnerable to rising interest rates) experienced a sharp decline
on the heels of late May’s rate rise. While BofA Merrill Lynch Global Research thinks the recent pullback could present a buying opportunity, investors should be aware of the heightened
risk of volatility in certain subsegments of the REIT market.
On June 6, 2013, the rate on five-year Indonesian bonds stood at 5.3%, the rate on five-year Treasuries at approximately 1%.
Investors may also purchase U.S.-dollar-denominated foreign bonds that are less affected by currency fluctuations, but at a time when global growth is expected to improve—and
emerging-market currencies to appreciate more rapidly than the dollar—that may not be the best move. In such an environment, buying emerging-market bonds denominated in their
own local currency could create an additional tailwind for foreign bond returns that could further help counteract the effect of rising rates.
Rising Interest Rates and Your Portfolio6
globally flexible bond funds is one way to outsource the
difficult work of shopping the world for appropriate fixedincome opportunities. Wolfe and his team call such funds
“no excuse” strategies, because of their willingness to use
every tool in their toolboxes—hedging, the ability to roam
between countries and types of credit, go long or short,
leverage and hedge against currency fluctuations—in the
pursuit of positive real returns. The disadvantage of such
funds, relative to individual bonds, is that it’s harder to tell
exactly what they are invested in, and their distributions are
less predictable than the regular coupons of an individual
security, and they can entail higher fees. Any well-diversified
investor would, however, want to consider including such
funds as part of the mix.
ONE WAY TO ROOT FOR HIGHER RATES
Another important component of the satellite—one that has
become popular in recent months—is the senior loan. One
of the most direct ways to gain exposure to a rise in interest
rates, these debt securities, issued by corporations who want
a cheap form of short-term financing, automatically readjust
their coupons whenever short-term interest rates go up.
Another plus is that they reside higher in the credit hierarchy
than high-yield bonds, so if the risk of default becomes an
issue, senior loan holders will get paid first.
One caveat, however: Holding senior loan securities will not
provide investors with blanket coverage against the risk
of rising interest rates. That’s because if a company itself
has failed to hedge against that risk, “the first thing they’re
going to do is pay off those bonds,” Wolfe explains. “They’re
not going to suffer rates rising.” When a company calls its
notes early, bondholders receive cash that they can reinvest
elsewhere—but it also means they’ve lost some exposure
to higher rates. Investors, therefore, need to be thoughtful
about the specific senior loan bonds in their portfolios, and
the companies that issue them. Here, too, says Wolfe, buying
into an actively managed fund that focuses on senior loans
“is probably a good way to go.” One more thing to keep in
mind: short-term rates probably won’t begin rising until the
Fed starts raising its overnight borrowing rate—which, as
Bernanke indicated, likely won’t be until 2015. So, senior
loans may not provide much protection against any rise in
longer-term rates that occurs between now and then.
Investors need to be thoughtful
about the specific senior loan
bonds in their portfolios, and the
companies that issue them.
ENDGAMES
No one can know with complete certainty what will happen
with interest rates in the coming months. The outcome
will hinge on the pace of the economy’s improvement and
the ability of the Fed to engineer a smooth transition out
of its policies of the past several years. At the same time,
the actions and reactions of bond investors themselves will
also figure heavily into where interest rates and bond prices
eventually settle out. “Let’s say the 10-year Treasury yield
keeps going to 3.5% or even 4%, but inflation stays at 2.5%,”
says Wolfe, “then all of a sudden Treasuries become a very
good investment again, and you could see money flowing
back into Treasuries and helping to stabilize yields right
there.” The situation is fluid, in other words. All the more
reason for investors to start preparing their bond portfolios
now and to have a firm grasp on what they ultimately hope
to achieve.
For more information about the impact of rising interest rates
on investment portfolios, please see our recent whitepaper
“Fixed Income Investing for a Rising Rate Environment.”
Rising Interest Rates and Your Portfolio7
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not take into account the specific investment objectives, financial situation and particular needs of any specific person who may receive it. Investors should understand that statements
regarding future prospects may not be realized.
Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.
Dividend payments are not guaranteed. The amount of a dividend payment, if any, can vary over time.
TIPS pay interest at a fixed rate. Because the rate is applied to the adjusted principal, interest payments can vary from one period to the next. If inflation occurs, the interest payment
increases. If deflation occurs, the interest payment decreases.
Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments, and yields and share
price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa.
Income from investing in municipal bonds is generally exempt from federal and state taxes for residents of the issuing state. While the interest income is tax exempt, any capital gains
distributed are taxable to the investor. Income for some investors may be subject to the federal alternative minimum tax (AMT).
Investments in high-yield bonds (sometimes referred to as “junk bonds”) offer the potential for high current income and attractive total return, but involves certain risks. Changes in
economic conditions or other circumstances may adversely affect a junk bond issuer’s ability to make principal and interest payments.
Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates,
and risks related to renting properties, such as rental defaults.
Investments in securities of master limited partnerships (MLPs) involve risks that differ from investments in common stock, including risks related to limited control and limited rights to
vote on matters affecting the MLP.
Investments in foreign securities involve special risks, including foreign currency risk and the possibility of substantial volatility due to adverse political, economic or other developments.
These risks are magnified for investments made in emerging markets.
© 2013 Bank of America Corporation
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